A genuine, non-sarcastic, authentic “hurrah” to this Tweeted statement from President Trump: “There will be NO change to your 401(k). This has always been a great and popular middle class tax break that works, and it stays!”
There are three main ways that Americans can save money for retirement. The first is an individual retirement account (IRA), where the money is not taxed when you deposit it or as it grows in value, but you pay income taxes when you withdraw it after retiring. The second is a Roth IRA, where you pay income tax on the money when you put it in, but don’t pay taxes on withdrawals when you retire. The third is the 401(k), which operates like a traditional IRA but your employer offers a matching contribution up to a certain percentage of your salary. Many financial planners will advise you to contribute as much as you can afford to your 401(k), or at least to the matching limit, because if you don’t, you’re effectively turning down free money for retirement from your employer.
The New York Timesreported Friday that House Republicans were considering a plan to sharply reduce the amount of income American workers can save in tax-deferred retirement accounts as part of a broad effort to rewrite the tax code. Right now, you can put up to $18,000 in 401(k) accounts and not pay taxes on that money, $24,000 if you’re over age 50. (The IRS recently announced that the limit will go up to $18,500 next year.)
The Times article reported that one of the ideas under consideration was reducing the annual amount workers can set aside to as low as $2,400. Eliminating the tax break for 401(k)s entirely in 2018 would generate $115 billion in new revenue. Our Andrew Stuttaford rightly labeled this idea “idiocy” and it’s such a bad idea, it’s fair to wonder just how seriously this idea was considered. It’s usually voices on the left that want to eliminate the tax incentives for saving money.
Still, as she sat at the witness table on Oct. 7 at a hearing of the House Committee on Education and Labor, running through the litany of what’s wrong with the 401(k) and other defined-contribution retirement plans — they have high fees, for one — Ghilarducci didn’t think she was courting controversy. “I was saying things that seemed completely milquetoast,” she recalls. Ghilarducci did bring up a bold proposal to replace the 401(k) with a mandatory, government-run pension plan and suggested that Congress immediately allow retirees to swap 401(k)s battered by the stock market’s collapse for monthly payouts from the government. But she had floated both ideas before, to little effect.
President Obama was pretty pro-IRA as far as Democratic presidents go. Back on the campaign trail in 2008, he said he wanted to require employers who do not offer retirement plans to offer their workers access to automatic IRAs and contribute via payroll deduction. Given a choice between mandating employers create IRAs and mandating they provide health insurance, I would have chosen the former. Unfortunately, Obama prioritized the latter, and after Obamacare, neither a Democrat nor Republican-run Congress was willing to force employers to provide another benefit to all employees.
Later in his presidency, Obama shifted to the “MyRA,” a nice enough idea that never really worked. The idea was a “no-fee, no-minimum-investment version of a Roth individual retirement account,” allowing up to $5,500 per year invested in government bonds.
Unfortunately, the idea flopped:
Running the entire program through the federal government, the Obama administration spent $70 million and only got 20,000 Americans to invest — an outrageous cost of $3,500 for each new account. Of that, $10 million went to a single bank — Comerica — to act as custodian for this small number of simple, non-trading accounts.
But President Obama had worse ideas. Back in 2013, he proposed eliminating certain tax advantages on IRAs and other tax-preferred retirement accounts when funds exceed a certain threshold. The threshold was pretty high — $3 million or so — but once again, Congress saw little appetite for punishing people who had saved a lot of money for retirement.
The Obama administration also flirted with the idea of taxing 529 college savings accounts.
What kind of tax hit might that have added up to for families who are just about to start 529 accounts themselves? I asked Vanguard to run some numbers. Parents who deposited $5,000 a year over 18 years and got a 6 percent return each year on their money would eventually end up with $179,140.48 that they could draw on during college.
That’s a lot of tax-free growth, so it’s only natural that it might have become a target. A family in the 25 percent tax bracket would have paid $22,285.12 in income taxes on that growth under the president’s plan if they withdrew it over four years, according to Vanguard. A household earning enough to be in the 35 percent tax bracket would have paid $31,199.17.
The administration abandoned that plan after a week of scathing press coverage.
Eliminating the tax benefits for 401(k)s and retirement savings was a terrible idea when Democrats proposed it, and reducing the tax benefits is an almost as equally terrible idea from Republicans.